Many tort lawsuits are resolved by an insured defendant’s stipulating to a judgment in favor of the plaintiff, and the plaintiff’s agreeing not to execute on the judgment against any of the defendant’s assets except for its insurance.  Simultaneously, the defendant typically assigns its claims against its insurer to the settling plaintiff, who then pursues recovery for the judgment directly from the insurer.  Under Washington law, in cases in which the insurer has failed in bad faith to defend, or has engaged in bad faith while defending under a reservation of rights, the insurer is estopped from contending that the underlying claim was not covered.  If certain procedures are followed, courts will also impose a rebuttable presumption that the stipulated judgment was a reasonable settlement that establishes the amount of harm caused to the defendant by the insurer’s bad faith.

But there are limitations to this method of settlement, and parties that do not properly document their agreement risk losing coverage for the judgment, even if an insurer has committed bad faith.  Division One of the Washington Court of Appeals recently held that an insurer who acted in bad faith in defending its policyholder could avoid coverage by estoppel, or alternatively rebut the presumption of harm to the insured, because the insured had been unconditionally released by the plaintiff in the underlying lawsuit.  In Mutual of Enumclaw Company v. Day, two pedestrians were injured by a teen driver after the driver purchased alcohol from Day’s grocery store.  The victims sued Day.  Faced with uncertainty over whether she was insured for the claim in the lawsuit, Day stipulated to a nearly $8 million judgment and assigned claims against her insurance agent, but retained the right to pursue a claim against her insurer.

This approach might have worked, except that the underlying plaintiffs had agreed that the stipulated judgment against Day would be fully satisfied when the assigned claim against the insurance agent was resolved, regardless of the outcome of Day’s retained claim against her insurer.  In the more typical settlement scenario, at least one asset of the insured defendant remains subject to the stipulated judgment, even if it is only the insurance policy.  It is that liability that creates coverage by estoppel and supports a presumption of harm to the insured; the only question is the amount of the harm, which the stipulated judgment normally provides.  But the Day court held that when a plaintiff is willing to release a defendant from liability without conditioning that release on an insurance assignment or recovery, the insurer’s conduct could not be said to have caused any harm.  Because there had been no harm, the court of appeals reversed the trial court’s decision to award Day the amount of the underlying settlement.

One might argue that the presumption of harm to the insured is no less a fiction in the typical assignment scenario, in which the settling insured is as a practical matter insulated from any direct responsibility for a settlement, than it was in the Day case.  The difference lies in the fact that in the former case a plaintiff would presumably have continued to pursue the insured defendant directly but for the value of the insurance assignment.  In the Day case, no such presumption can be made, since the plaintiff was willing to abandon its pursuit of the defendant without obtaining anything of value from her insurer.  Under those circumstances, coverage by estoppel does not apply.

The lesson for practitioners and parties is to be extremely careful in structuring settlements involving insurance assets, because decisions on whether to enforce such settlements can turn on seemingly pointless aspects of insurance law.  That is true whether the settlement occurs in Washington, with its robust protections for policyholders, including coverage by estoppel and presumptive damages in coverage actions, or in Oregon, where the law is less fully developed and protections are fewer, or in other states that have different approaches.